|
|
Item 1.
|
Financial Statements
|
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
March 31,
2016
|
|
December 31,
2015
|
ASSETS
|
|
|
|
Current assets:
|
|
|
|
Cash and cash equivalents
|
$
|
40,539
|
|
|
$
|
47,315
|
|
Short-term investments
|
46,289
|
|
|
51,814
|
|
Trade accounts receivable, net of allowances
|
23,527
|
|
|
22,511
|
|
Deferred costs, current portion
|
452
|
|
|
460
|
|
Prepaid expenses and other current assets
|
5,563
|
|
|
7,140
|
|
Total current assets
|
116,370
|
|
|
129,240
|
|
Equipment, software, and leasehold improvements, at cost:
|
|
|
|
Equipment and software
|
61,330
|
|
|
66,702
|
|
Leasehold improvements
|
3,190
|
|
|
3,122
|
|
Total equipment, software, and leasehold improvements, at cost
|
64,520
|
|
|
69,824
|
|
Less accumulated depreciation and amortization
|
56,983
|
|
|
61,024
|
|
Net equipment, software, and leasehold improvements
|
7,537
|
|
|
8,800
|
|
Restricted cash equivalents and investments
|
3,100
|
|
|
2,890
|
|
Available for sale securities
|
1,910
|
|
|
1,721
|
|
Other assets
|
2,273
|
|
|
2,307
|
|
Deferred costs, non-current portion
|
660
|
|
|
212
|
|
Deferred tax assets, net
|
996
|
|
|
957
|
|
Other intangible assets, net
|
1,753
|
|
|
2,136
|
|
Goodwill
|
13,099
|
|
|
13,080
|
|
Total assets
|
$
|
147,698
|
|
|
$
|
161,343
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
Current liabilities:
|
|
|
|
Accounts payable
|
$
|
15,368
|
|
|
$
|
17,050
|
|
Accrued and other current liabilities
|
17,110
|
|
|
17,320
|
|
Deferred revenue, current portion
|
3,537
|
|
|
3,497
|
|
Total current liabilities
|
36,015
|
|
|
37,867
|
|
Deferred revenue, non-current portion
|
583
|
|
|
105
|
|
Deferred rent
|
579
|
|
|
620
|
|
Deferred tax liabilities, net
|
90
|
|
|
88
|
|
Other long-term liabilities
|
1,668
|
|
|
1,980
|
|
Total liabilities
|
38,935
|
|
|
40,660
|
|
Commitments and contingencies
|
|
|
|
Shareholders’ equity:
|
|
|
|
Preferred stock, $0.001 par value, no shares issued and outstanding:
|
|
|
|
Series A: authorized 200 shares
|
—
|
|
|
—
|
|
Undesignated series: authorized 59,800 shares
|
—
|
|
|
—
|
|
Common stock, $0.001 par value authorized 250,000 shares; issued and outstanding 36,747 shares in 2016 and 36,298 shares in 2015
|
36
|
|
|
36
|
|
Additional paid-in capital
|
629,716
|
|
|
627,316
|
|
Accumulated other comprehensive loss
|
(58,629
|
)
|
|
(59,480
|
)
|
Retained deficit
|
(462,360
|
)
|
|
(447,189
|
)
|
Total shareholders’ equity
|
108,763
|
|
|
120,683
|
|
Total liabilities and shareholders’ equity
|
$
|
147,698
|
|
|
$
|
161,343
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Net revenue (A)
|
$
|
28,230
|
|
|
$
|
30,597
|
|
Cost of revenue (B)
|
15,172
|
|
|
16,547
|
|
Gross profit
|
13,058
|
|
|
14,050
|
|
Operating expenses:
|
|
|
|
Research and development
|
9,319
|
|
|
12,379
|
|
Sales and marketing
|
9,225
|
|
|
12,837
|
|
General and administrative
|
8,077
|
|
|
7,283
|
|
Restructuring and other charges
|
385
|
|
|
485
|
|
Lease exit and related charges
|
831
|
|
|
78
|
|
Total operating expenses
|
27,837
|
|
|
33,062
|
|
Operating income (loss)
|
(14,779
|
)
|
|
(19,012
|
)
|
Other income (expenses):
|
|
|
|
Interest income, net
|
117
|
|
|
200
|
|
Gain (loss) on investments, net
|
3
|
|
|
299
|
|
Equity in net loss of Rhapsody investment
|
—
|
|
|
(6,180
|
)
|
Other income (expense), net
|
(287
|
)
|
|
443
|
|
Total other income (expenses), net
|
(167
|
)
|
|
(5,238
|
)
|
Income (loss) before income taxes
|
(14,946
|
)
|
|
(24,250
|
)
|
Income tax expense (benefit)
|
225
|
|
|
219
|
|
Net income (loss)
|
$
|
(15,171
|
)
|
|
$
|
(24,469
|
)
|
|
|
|
|
Basic net income (loss) per share
|
$
|
(0.42
|
)
|
|
$
|
(0.68
|
)
|
Diluted net income (loss) per share
|
$
|
(0.42
|
)
|
|
$
|
(0.68
|
)
|
Shares used to compute basic net income (loss) per share
|
36,520
|
|
|
36,104
|
|
Shares used to compute diluted net income (loss) per share
|
36,520
|
|
|
36,104
|
|
|
|
|
|
Comprehensive income (loss):
|
|
|
|
Unrealized investment holding gains (losses), net of reclassification adjustments
|
$
|
151
|
|
|
$
|
(94
|
)
|
Foreign currency translation adjustments, net of reclassification adjustments
|
700
|
|
|
(2,585
|
)
|
Total other comprehensive income (loss)
|
851
|
|
|
(2,679
|
)
|
Net income (loss)
|
(15,171
|
)
|
|
(24,469
|
)
|
Comprehensive income (loss)
|
$
|
(14,320
|
)
|
|
$
|
(27,148
|
)
|
|
|
|
|
(A) Components of net revenue:
|
|
|
|
License fees
|
$
|
5,777
|
|
|
$
|
7,289
|
|
Service revenue
|
22,453
|
|
|
23,308
|
|
|
$
|
28,230
|
|
|
$
|
30,597
|
|
(B) Components of cost of revenue:
|
|
|
|
License fees
|
$
|
1,304
|
|
|
$
|
1,743
|
|
Service revenue
|
13,868
|
|
|
14,804
|
|
|
$
|
15,172
|
|
|
$
|
16,547
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
2016
|
|
2015
|
Cash flows from operating activities:
|
|
|
|
Net income (loss)
|
$
|
(15,171
|
)
|
|
$
|
(24,469
|
)
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
|
|
|
|
Depreciation and amortization
|
2,598
|
|
|
2,503
|
|
Stock-based compensation
|
3,171
|
|
|
1,329
|
|
Equity in net loss of Rhapsody
|
—
|
|
|
6,180
|
|
Deferred income taxes, net
|
(128
|
)
|
|
(77
|
)
|
Loss (gain) on investments, net
|
(3
|
)
|
|
(299
|
)
|
Fair value of warrants granted in 2015, net of subsequent mark to market adjustments in 2016 and 2015
|
44
|
|
|
(1,155
|
)
|
Trade accounts receivable
|
(487
|
)
|
|
(654
|
)
|
Prepaid expenses and other assets
|
1,322
|
|
|
621
|
|
Accounts payable
|
(2,106
|
)
|
|
(62
|
)
|
Accrued and other liabilities
|
(451
|
)
|
|
(4,011
|
)
|
Net cash provided by (used in) operating activities
|
(11,211
|
)
|
|
(20,094
|
)
|
Cash flows from investing activities:
|
|
|
|
Purchases of equipment, software, and leasehold improvements
|
(828
|
)
|
|
(306
|
)
|
Proceeds from sale of available for sale securities
|
—
|
|
|
352
|
|
Purchases of short-term investments
|
(17,876
|
)
|
|
(6,018
|
)
|
Proceeds from sales and maturities of short-term investments
|
23,401
|
|
|
33,077
|
|
Decrease (increase) in restricted cash equivalents and investments, net
|
(210
|
)
|
|
—
|
|
Advance to Rhapsody
|
—
|
|
|
(5,000
|
)
|
Net cash provided by (used in) investing activities
|
4,487
|
|
|
22,105
|
|
Cash flows from financing activities:
|
|
|
|
Proceeds from issuance of common stock (stock options and stock purchase plan)
|
16
|
|
|
6
|
|
Tax payments from shares withheld upon vesting of restricted stock
|
(787
|
)
|
|
(7
|
)
|
Net cash provided by (used in) financing activities
|
(771
|
)
|
|
(1
|
)
|
Effect of exchange rate changes on cash and cash equivalents
|
719
|
|
|
(2,269
|
)
|
Net increase (decrease) in cash and cash equivalents
|
(6,776
|
)
|
|
(259
|
)
|
Cash and cash equivalents, beginning of period
|
47,315
|
|
|
103,253
|
|
Cash and cash equivalents, end of period
|
$
|
40,539
|
|
|
$
|
102,994
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
Cash received from income tax refunds
|
$
|
389
|
|
|
$
|
229
|
|
Cash paid for income taxes
|
$
|
624
|
|
|
$
|
229
|
|
Non-cash investing activities:
|
|
|
|
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements
|
$
|
44
|
|
|
$
|
49
|
|
Acquisition of intangible assets
|
$
|
—
|
|
|
$
|
473
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters Ended
March 31, 2016
and
2015
|
|
|
Note 1
|
Description of Business and Summary of Significant Accounting Policies
|
Description of Business.
RealNetworks, Inc. and subsidiaries is a global provider of network-delivered digital media applications and services that make it easy to manage, play and share digital media. The Company also develops and markets software products and services that enable the creation, distribution and consumption of digital media, including audio and video.
Inherent in our business are various risks and uncertainties, including a limited history of certain of our product and service offerings. RealNetworks' success will depend on the acceptance of our technology, products and services and the ability to generate related revenue.
In this Quarterly Report on Form 10-Q (10-Q or Report), RealNetworks, Inc. and Subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”. "RealPlayer
®
" and other trademarks of ours appearing in this report are our property.
Basis of Presentation.
The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the
quarter ended
March 31, 2016
are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending
December 31, 2016
. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended
December 31, 2015
(the 10-K).
Use of Estimates.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Reportable Segments.
In the first quarter of 2016, we reorganized the management of our businesses and as a result, we
changed our reportable segments. See
Note 18
,
Segment Information
, for details. The historical financial information presented has been recast to reflect the new segments and the new corporate expense presentation.
|
|
|
Note 2
|
Recent Accounting Pronouncements
|
In August 2014, the Financial Accounting Standards Board (FASB) issued a new standard, "Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern". This standard provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. The new guidance is effective for all annual and interim periods ending after December 15, 2016. We are currently evaluating the impact, if any, the adoption of this standard will have on our consolidated financial statements.
In May 2014, the FASB issued new revenue recognition guidance. The guidance will require an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new guidance is effective for us on January 1, 2018; with early adoption permitted beginning January 1, 2017. The guidance permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that the guidance will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor determined the effect of the standard on our ongoing financial reporting.
In February 2016, the FASB issued new guidance related to the accounting for leases by lessees. A major change in the new guidance is that lessees will be required to present right-of-use assets and lease liabilities on the balance sheet. The new guidance will be effective for us on January 1, 2019, including interim periods within 2019. We will be evaluating the effect that the guidance will have on our consolidated financial statements and related disclosures.
In March 2016, the FASB issued new guidance that is intended to simplify several aspects of the accounting for stock-based compensation, including the treatment of forfeitures, income taxes and statutory tax withholding requirements. The new guidance will be effective for us on January 1, 2017, including interim periods within 2017; with early adoption permitted beginning January 1, 2016. We will be evaluating the effect that the guidance will have on our consolidated financial statements and related disclosures.
There have been no other recent accounting pronouncements or changes in accounting pronouncements to be implemented that are of significance or potential significance to RealNetworks.
|
|
|
Note 3
|
Acquisitions & Disposals
|
2015 Sale of Slingo and social casino business.
On July 24, 2015, we entered into an agreement to sell the Slingo and social casino portion of our games business to Gaming Realms plc for
$18.0 million
. Of this amount,
$10.0 million
of the total consideration was paid in cash at closing on August 10, 2015 and the remaining
$8.0 million
will be payable either all in cash or a mix of cash and Gaming Realms plc stock, at our election, on the first and second anniversaries of the closing.
With the transaction, Gaming Realms plc assumed the operations of our Slingo and social casino businesses, including substantially all of the related assets and liabilities, as well as the stock of Backstage Technologies Incorporated. Based on several factors, including the timing of the receipt of the remaining
$8.0 million
consideration, we deferred the remaining gain of
$8.0 million
and will recognize that gain upon realization.
|
|
|
Note 4
|
Stock-Based Compensation
|
Total stock-based compensation expense recognized in our unaudited condensed consolidated statements of operations and comprehensive income (loss) includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Total stock-based compensation expense
|
$
|
3,171
|
|
|
$
|
1,329
|
|
The fair value of options granted determined using the Black-Scholes model used the following weighted-average assumptions:
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Expected dividend yield
|
0
|
%
|
|
0
|
%
|
Risk-free interest rate
|
1.54
|
%
|
|
1.20
|
%
|
Expected life (years)
|
5.5
|
|
|
4.2
|
|
Volatility
|
38
|
%
|
|
37
|
%
|
The total stock-based compensation amounts for
2016
and
2015
disclosed above are recorded in their respective line items within operating expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). Included in the expense for the period ended March 31, 2016 was stock compensation expense related to our 2015 incentive bonuses paid in fully vested restricted stock units which were authorized and granted in the first quarter of 2016.
As of
March 31, 2016
,
$7.1 million
of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately
2
years.
|
|
|
Note 5
|
Rhapsody Joint Venture
|
As of
March 31, 2016
we owned approximately
42%
of the issued and outstanding stock of Rhapsody and account for our investment using the equity method of accounting.
Rhapsody was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International Inc. (MTVN), to own and operate a business-to-consumer digital audio music service known as Rhapsody.
Following certain restructuring transactions effective March 31, 2010, we began accounting for our investment in Rhapsody using the equity method of accounting. As part of the 2010 restructuring transactions, RealNetworks contributed
$18.0 million
in cash, the Rhapsody brand and certain other assets, including content licenses, in exchange for shares of convertible preferred stock of Rhapsody, carrying a
$10.0 million
preference upon certain liquidation events.
We recorded our share of losses of Rhapsody of
$0.0 million
and
$6.2 million
for the
quarters ended
March 31, 2016
and
2015
, respectively. Because of the
$10.0 million
liquidation preference on the preferred stock we hold in Rhapsody, under the equity method of accounting we did not record any share of Rhapsody losses that would reduce our carrying value of Rhapsody, which is impacted by Rhapsody equity transactions, below
$10.0 million
, until Rhapsody's book value was reduced below
$10.0 million
. This occurred in the first quarter of 2015. As of
March 31, 2016
, the carrying value of our Rhapsody equity investment is
zero
, as we do not record any share of Rhapsody losses that would reduce our carrying value of Rhapsody below zero unless we commit to provide financial support for Rhapsody.
Summarized financial information for Rhapsody, which represents
100%
of their financial information, is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Net revenue
|
$
|
52,507
|
|
|
$
|
46,324
|
|
Gross profit
|
7,243
|
|
|
8,090
|
|
Net loss
|
(5,148
|
)
|
|
(8,924
|
)
|
|
|
|
Note 6
|
Fair Value Measurements
|
Items Measured at Fair Value on a Recurring Basis
The following table presents information about our financial assets that have been measured at fair value on a recurring basis as of
March 31, 2016
and
December 31, 2015
, and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of
|
|
Amortized Cost as of
|
|
March 31, 2016
|
|
March 31, 2016
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
24,701
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
24,701
|
|
|
$
|
24,701
|
|
Money market funds
|
6,612
|
|
|
—
|
|
|
—
|
|
|
6,612
|
|
|
6,612
|
|
Corporate notes and bonds
|
—
|
|
|
9,226
|
|
|
—
|
|
|
9,226
|
|
|
9,226
|
|
Total cash and cash equivalents
|
31,313
|
|
|
9,226
|
|
|
—
|
|
|
40,539
|
|
|
40,539
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds
|
—
|
|
|
46,289
|
|
|
—
|
|
|
46,289
|
|
|
46,285
|
|
Total short-term investments
|
—
|
|
|
46,289
|
|
|
—
|
|
|
46,289
|
|
|
46,285
|
|
Restricted cash equivalents and investments
|
—
|
|
|
3,100
|
|
|
—
|
|
|
3,100
|
|
|
3,100
|
|
Equity investment in publicly traded securities
|
1,910
|
|
|
—
|
|
|
—
|
|
|
1,910
|
|
|
362
|
|
Warrant issued by Rhapsody (included in Other assets)
|
—
|
|
|
—
|
|
|
1,009
|
|
|
1,009
|
|
|
—
|
|
Total
|
$
|
33,223
|
|
|
$
|
58,615
|
|
|
$
|
1,009
|
|
|
$
|
92,847
|
|
|
$
|
90,286
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of
|
|
Amortized Cost as of
|
|
December 31, 2015
|
|
December 31, 2015
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
23,152
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
23,152
|
|
|
$
|
23,152
|
|
Money market funds
|
5,061
|
|
|
—
|
|
|
—
|
|
|
5,061
|
|
|
5,061
|
|
Corporate notes and bonds
|
—
|
|
|
19,102
|
|
|
—
|
|
|
19,102
|
|
|
19,102
|
|
Total cash and cash equivalents
|
28,213
|
|
|
19,102
|
|
|
—
|
|
|
47,315
|
|
|
47,315
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds
|
—
|
|
|
51,814
|
|
|
—
|
|
|
51,814
|
|
|
51,862
|
|
Total short-term investments
|
—
|
|
|
51,814
|
|
|
—
|
|
|
51,814
|
|
|
51,862
|
|
Restricted cash equivalents and investments
|
—
|
|
|
2,890
|
|
|
—
|
|
|
2,890
|
|
|
2,890
|
|
Equity investment in publicly traded securities
|
1,721
|
|
|
—
|
|
|
—
|
|
|
1,721
|
|
|
362
|
|
Warrant issued by Rhapsody (included in Other assets)
|
—
|
|
|
—
|
|
|
1,053
|
|
|
1,053
|
|
|
—
|
|
Total
|
$
|
29,934
|
|
|
$
|
73,806
|
|
|
$
|
1,053
|
|
|
$
|
104,793
|
|
|
$
|
102,429
|
|
Restricted cash equivalents and investments as of
March 31, 2016
and
December 31, 2015
relate to cash pledged as collateral against letters of credit in connection with lease agreements.
Realized gains or losses on sales of short-term investment securities for the
quarters ended
March 31, 2016
and
2015
were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of
March 31, 2016
and
December 31, 2015
were also not significant.
Investments with remaining contractual maturities of five years or less are classified as short-term because the investments are marketable and highly liquid, and we have the ability to utilize them for current operations. Contractual maturities of short-term investments as of
March 31, 2016
(in thousands):
|
|
|
|
|
|
Estimated
Fair Value
|
Within one year
|
$
|
42,584
|
|
Between one year and five years
|
3,705
|
|
Total short-term investments
|
$
|
46,289
|
|
Our equity investment in a publicly traded company as of
March 31, 2016
and
December 31, 2015
consisted of J-Stream Inc., a Japanese media services company. This equity investment is accounted for as available for sale. In March 2015, we sold a portion of the J-Stream shares we held, resulting in cash proceeds of
$0.4 million
and a pre-tax gain of
$0.3 million
.
In February 2015, Rhapsody issued warrants to purchase Rhapsody common shares to each of RealNetworks and Rhapsody's one other
43%
stockholder. The warrants were issued as compensation for past services provided by RealNetworks and the other 43% stockholder, and both warrants covered the same number of underlying shares. The exercise price of the warrants was equal to the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of
5 years
and expected volatility of
55%
. On the date of issuance, we recognized and recorded the
$1.2 million
fair value of the warrant issued to RealNetworks within other assets in the unaudited condensed consolidated balance sheets, and as an expense reduction within General and administrative expense in the unaudited condensed consolidated statements of operations. The warrants are free-standing derivatives and as such their fair value is determined each quarter using updated inputs in the Black-Scholes option-pricing model. During the
three months ended March 31, 2016
, the decrease in the fair value of the warrants from
December 31, 2015
was insignificant.
Items Measured at Fair Value on a Non-recurring Basis
Certain of our assets and liabilities are measured at estimated fair value on a non-recurring basis, using Level 3 inputs. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). During the
three months ended March 31, 2016
and
2015
, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
See
Note 12
,
Lease Exit and Related Charges
, for a discussion of the losses related to reductions in the use of RealNetworks' office space, which were recorded at the estimated fair value of remaining lease obligations, less expected sub-lease income.
|
|
|
Note 7
|
Allowance for Doubtful Accounts Receivable and Sales Returns
|
Activity in the allowance for doubtful accounts receivable and sales returns (in thousands):
|
|
|
|
|
|
|
|
|
|
Allowance For
|
|
Doubtful
Accounts
Receivable
|
|
Sales
Returns
|
Balances, December 31, 2015
|
$
|
765
|
|
|
$
|
158
|
|
Addition (reduction) to allowance
|
(20
|
)
|
|
20
|
|
Amounts written off
|
(3
|
)
|
|
(3
|
)
|
Foreign currency translation
|
39
|
|
|
—
|
|
Balances, March 31, 2016
|
$
|
781
|
|
|
$
|
175
|
|
One
customer accounted for
54%
and
one
other customer accounted for
15%
of trade accounts receivable as of
March 31, 2016
. At
December 31, 2015
,
one
customer accounted for
52%
and
one
other customer accounted for
12%
of trade accounts receivable.
One
customer accounted for
30%
or
$8.4 million
of consolidated revenue during the
quarter ended March 31, 2016
, which is reflected in our Mobile Services segment.
One
customer accounted for
12%
of consolidated revenue, or
$3.5 million
, during the
quarter ended March 31, 2016
, also reflected in our Mobile Services segment.
One
customer accounted for
17%
of consolidated revenue, or
$5.3 million
, during the
quarter ended March 31, 2015
and is reflected in our Mobile Services segment.
|
|
|
Note 8
|
Other Intangible Assets
|
Other intangible assets (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2016
|
|
December 31, 2015
|
|
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
Amortizing intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
30,918
|
|
|
$
|
30,073
|
|
|
$
|
845
|
|
|
$
|
30,182
|
|
|
$
|
29,236
|
|
|
$
|
946
|
|
|
Developed technology
|
|
24,403
|
|
|
23,751
|
|
|
652
|
|
|
24,047
|
|
|
23,244
|
|
|
803
|
|
|
Patents, trademarks and tradenames
|
|
3,822
|
|
|
3,566
|
|
|
256
|
|
|
3,717
|
|
|
3,398
|
|
|
319
|
|
|
Service contracts
|
|
5,382
|
|
|
5,382
|
|
|
—
|
|
|
5,269
|
|
|
5,201
|
|
|
68
|
|
|
Total
|
|
$
|
64,525
|
|
|
$
|
62,772
|
|
|
$
|
1,753
|
|
|
$
|
63,215
|
|
|
$
|
61,079
|
|
|
$
|
2,136
|
|
No impairments of other intangible assets were recognized in either of the
three months ended March 31, 2016
or
2015
.
Changes in goodwill (in thousands):
|
|
|
|
|
Balance, December 31, 2015
|
$
|
13,080
|
|
Effects of foreign currency translation
|
19
|
|
Balance, March 31, 2016
|
$
|
13,099
|
|
Goodwill by segment (in thousands):
|
|
|
|
|
|
March 31,
2016
|
Consumer Media
|
$
|
580
|
|
Mobile Services
|
2,221
|
|
Games
|
10,298
|
|
Total goodwill
|
$
|
13,099
|
|
No impairment of goodwill was recognized in either of the
three months ended March 31, 2016
or in
2015
.
|
|
|
Note 10
|
Accrued and Other Current Liabilities
|
Accrued and other current liabilities (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31, 2016
|
|
December 31, 2015
|
Royalties and other fulfillment costs
|
$
|
2,592
|
|
|
$
|
3,094
|
|
Employee compensation, commissions and benefits
|
5,955
|
|
|
5,958
|
|
Sales, VAT and other taxes payable
|
3,006
|
|
|
2,976
|
|
Other
|
5,557
|
|
|
5,292
|
|
Total accrued and other current liabilities
|
$
|
17,110
|
|
|
$
|
17,320
|
|
|
|
|
Note 11
|
Restructuring Charges
|
Restructuring and other charges in
2016
and
2015
consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. The expense amounts in both years relate primarily to severance costs due to workforce reductions.
Restructuring charges are as follows (in thousands):
|
|
|
|
|
|
Employee Separation Costs
|
Costs incurred and charged to expense for the three months ended March 31, 2016
|
$
|
385
|
|
Costs incurred and charged to expense for the three months ended March 31, 2015
|
$
|
485
|
|
Changes to the accrued restructuring liability (which is included in Accrued and other current liabilities) for
2016
(in thousands) are as follows:
|
|
|
|
|
|
Employee Separation Costs
|
Accrued liability at December 31, 2015
|
$
|
1,404
|
|
Costs incurred and charged to expense for the three months ended March 31, 2016
|
385
|
|
Cash payments
|
(820
|
)
|
Accrued liability at March 31, 2016
|
$
|
969
|
|
|
|
|
Note 12
|
Lease Exit and Related Charges
|
As a result of the reduction in use of RealNetworks' office space, lease exit and related charges have been recognized representing rent and contractual operating expenses over the remaining life of the leases, including estimates of sublease income expected to be received. In the
quarter ended March 31, 2016
, we identified a subtenant and recorded an additional
$0.8 million
of losses due to a change in estimate for sublease income relating to the approximate
43%
reduction of office space at our corporate headquarters in Seattle, Washington in the third quarter of 2015. We continue to regularly evaluate the market for office space. If the market for such space changes further in future periods, we may have to revise our estimates which may result in future adjustments to expense for excess office facilities.
Changes to accrued lease exit and related charges (which is included in Accrued and other current liabilities) for
2016
(in thousands) are as follows:
|
|
|
|
|
Accrued loss at December 31, 2015
|
$
|
2,595
|
|
Additions and adjustments to the lease loss accrual, including estimated sublease income
|
831
|
|
Less amounts paid, net of sublease amounts
|
(514
|
)
|
Accrued loss at March 31, 2016
|
2,912
|
|
Less current portion (included in Accrued and other current liabilities)
|
(1,454
|
)
|
Accrued loss, non-current portion (included in Other long term liabilities)
|
$
|
1,458
|
|
|
|
|
Note 13
|
Shareholders’ Equity
|
Accumulated Other Comprehensive Income (Loss)
Changes in components of accumulated other comprehensive income (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
|
|
2016
|
|
2015
|
Investments
|
|
|
|
|
|
Accumulated other comprehensive income (loss), beginning of period
|
|
$
|
1,297
|
|
|
$
|
2,252
|
|
|
Unrealized gains (losses), net of tax effects of
$90 and $116 in 2016 and 2015
|
|
151
|
|
|
205
|
|
|
Reclassification adjustments for losses (gains) included in other income (expense), net of tax effects of $0 and $(1) in 2016 and 2015
|
|
—
|
|
|
(299
|
)
|
|
Net current period other comprehensive income (loss)
|
|
151
|
|
|
(94
|
)
|
|
Accumulated other comprehensive income (loss) balance, end of period
|
|
$
|
1,448
|
|
|
$
|
2,158
|
|
Foreign currency translation
|
|
|
|
|
|
Accumulated other comprehensive income (loss), beginning of period
|
|
$
|
(60,777
|
)
|
|
$
|
(57,504
|
)
|
|
Translation adjustments
|
|
700
|
|
|
(2,585
|
)
|
|
Net current period other comprehensive income (loss)
|
|
700
|
|
|
(2,585
|
)
|
|
Accumulated other comprehensive income (loss) balance, end of period
|
|
$
|
(60,077
|
)
|
|
$
|
(60,089
|
)
|
Total accumulated other comprehensive income (loss), end of period
|
|
$
|
(58,629
|
)
|
|
$
|
(57,931
|
)
|
As of
March 31, 2016
, there have been
no
material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the
2015
10-K. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
We file numerous consolidated and separate income tax returns in the U.S. including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal income tax examinations for tax years before 2013 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.
|
|
|
Note 15
|
Earnings (Loss) Per Share
|
Basic net income (loss) per share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) by the weighted average number of common and dilutive potential common shares outstanding during the period. Basic and diluted EPS (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Net income (loss)
|
$
|
(15,171
|
)
|
|
$
|
(24,469
|
)
|
Weighted average common shares outstanding used to compute basic EPS
|
36,520
|
|
|
36,104
|
|
Dilutive effect of stock based awards
|
—
|
|
|
—
|
|
Weighted average common shares outstanding used to compute diluted EPS
|
36,520
|
|
|
36,104
|
|
|
|
|
|
Basic EPS
|
$
|
(0.42
|
)
|
|
$
|
(0.68
|
)
|
Diluted EPS
|
$
|
(0.42
|
)
|
|
$
|
(0.68
|
)
|
During the
quarter ended
March 31, 2016
and March 31, 2015,
5.3 million
and
6.3 million
shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
|
|
|
Note 16
|
Commitments and Contingencies
|
We could in the future become subject to legal proceedings, governmental investigations and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. Such claims, even if not meritorious, could force us to expend significant financial and managerial resources. In addition, given the broad distribution of some of our consumer products, any individual claim related to those products could give rise to liabilities that may be material to us. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our consolidated financial statements.
In the ordinary course of business, RealNetworks is subject to potential obligations for standard warranty and indemnification provisions that are contained within many of our customer license and service agreements. Our warranty provisions are consistent with those prevalent in our industry, and we do not have a history of incurring losses on warranties; therefore, we do not maintain accruals for warranty-related obligations. With regard to indemnification provisions, nearly all of our carrier contracts obligate us to indemnify our carrier customers for certain liabilities that may be incurred by them. We have received in the past, and may receive in the future, claims for indemnification from some of our carrier customers.
In relation to certain patents and other technology assets we sold to Intel in the second quarter of 2012, we have specific obligations to indemnify Intel for breaches of the representations and warranties that we made and covenants that we agreed to in the asset purchase agreement for certain potential future intellectual property infringement claims brought by third parties against Intel. The amount of any potential liabilities related to our indemnification obligations to Intel will not be determined until a claim has been made, but we are obligated to indemnify Intel up to the amount of the gross purchase price that we received in the sale.
|
|
|
Note 18
|
Segment Information
|
In the first quarter of 2016, we reorganized the management of our businesses and as a result, we now report
three
segments: (1) Consumer Media, which includes our PC-based RealPlayer products, including RealPlayer Plus and related products and intellectual property licensing; (2) Mobile Services, which includes our SaaS services, our LISTEN
®
product, and our Mobile RealTimes
®
product that is primarily sold through mobile carriers; and (3) Games, which includes all our games-related businesses, including sales of games licenses, online games subscription services, advertising on games sites and social network sites, microtransactions from online and social games, and sales of mobile games.
We allocate certain corporate expenses which are directly attributable to supporting our businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities, to our reportable segments. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. Also reported in our corporate segment were restructuring charges, lease exit and related charges, as well as stock compensation charges. Concurrent with the segment change described above, we also changed our corporate expense allocation methodology to increase accountability, resulting in an increase in costs allocated to the Consumer Media and Mobile Services businesses.
RealNetworks reports three reportable segments based on factors such as how we manage our operations and how our Chief Operating Decision Maker (CODM) reviews results. The CODM reviews financial information presented on both a consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1, Description of Business and Summary of Significant Accounting Policies, in the 10-K.
The historical financial information presented has been recast to reflect the new segments and the new corporate expense presentation. Segment results for the
quarters ended
March 31, 2016
and
2015
(in thousands):
Consumer Media
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Revenue
|
$
|
5,726
|
|
|
$
|
7,989
|
|
Cost of revenue
|
2,417
|
|
|
3,464
|
|
Gross profit
|
3,309
|
|
|
4,525
|
|
Operating expenses
|
5,376
|
|
|
6,594
|
|
Operating income (loss)
|
$
|
(2,067
|
)
|
|
$
|
(2,069
|
)
|
Mobile Services
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Revenue
|
$
|
16,465
|
|
|
$
|
14,504
|
|
Cost of revenue
|
10,917
|
|
|
10,308
|
|
Gross profit
|
5,548
|
|
|
4,196
|
|
Operating expenses
|
9,794
|
|
|
11,961
|
|
Operating income (loss)
|
$
|
(4,246
|
)
|
|
$
|
(7,765
|
)
|
Games
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Revenue
|
$
|
6,039
|
|
|
$
|
8,104
|
|
Cost of revenue
|
1,845
|
|
|
2,794
|
|
Gross profit
|
4,194
|
|
|
5,310
|
|
Operating expenses
|
5,295
|
|
|
8,683
|
|
Operating income (loss)
|
$
|
(1,101
|
)
|
|
$
|
(3,373
|
)
|
Corporate
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
Cost of revenue
|
$
|
(7
|
)
|
|
$
|
(19
|
)
|
Operating expenses
|
7,372
|
|
|
5,824
|
|
Operating income (loss)
|
$
|
(7,365
|
)
|
|
$
|
(5,805
|
)
|
Our customers consist primarily of consumers and corporations located in the U.S., Europe, Republic of Korea and various foreign countries (Rest of the World). Revenue by geographic region (in thousands):
|
|
|
|
|
|
|
|
|
|
Quarters Ended
March 31,
|
|
2016
|
|
2015
|
United States
|
$
|
10,383
|
|
|
$
|
12,349
|
|
Europe
|
3,384
|
|
|
4,163
|
|
Republic of Korea
|
9,233
|
|
|
6,324
|
|
Rest of the World
|
5,230
|
|
|
7,761
|
|
Total net revenue
|
$
|
28,230
|
|
|
$
|
30,597
|
|
Long-lived assets (which consist of equipment, software, leasehold improvements, other intangible assets, and goodwill) by geographic region (in thousands) are as follows:
|
|
|
|
|
|
|
|
|
|
March 31,
2016
|
|
December 31,
2015
|
United States
|
$
|
15,012
|
|
|
$
|
16,821
|
|
Europe
|
4,544
|
|
|
4,898
|
|
Republic of Korea
|
268
|
|
|
282
|
|
Rest of the World
|
2,565
|
|
|
2,015
|
|
Total long-lived assets
|
$
|
22,389
|
|
|
$
|
24,016
|
|
|
|
|
Note 19
|
Related Party Transactions
|
See
Note 5
,
Rhapsody Joint Venture
, and
Note 6
,
Fair Value Measurements
, for details on transactions involving Rhapsody.
|
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about RealNetworks’ industry, products, management’s beliefs, and certain assumptions made by management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. All statements contained in this report that do not relate to matters of historical fact should be considered forward-looking statements. Forward-looking statements include statements with respect to:
|
|
•
|
the expected benefits and other consequences of our growth plans, strategic initiatives, and restructurings;
|
|
|
•
|
our expected introduction, distribution and monetization, of new and enhanced products, services and technologies across our businesses;
|
|
|
•
|
future revenues, operating expenses, income and other taxes, tax benefits, net income (loss) per diluted share available to common shareholders, acquisition costs and related amortization, and other measures of results of operations;
|
|
|
•
|
the effects of our past acquisitions and expectations for future acquisitions and divestitures;
|
|
|
•
|
plans, strategies and expected opportunities for future growth, increased profitability and innovation;
|
|
|
•
|
the expected financial position, performance, growth and profitability of, and investment in, our businesses and the availability of resources;
|
|
|
•
|
the effects of legislation, regulations, administrative proceedings, court rulings, settlement negotiations and other factors that may impact our businesses;
|
|
|
•
|
the continuation and expected nature of certain customer relationships;
|
|
|
•
|
impacts of competition and certain customer relationships on the future financial performance and growth of our businesses;
|
|
|
•
|
our involvement in potential claims, legal proceedings and government investigations, and the potential outcomes and effects of such potential claims, legal proceedings and governmental investigations on our business, prospects, financial condition or results of operations;
|
|
|
•
|
the effects of U.S. and foreign income and other taxes on our business, prospects, financial condition or results of operations; and
|
|
|
•
|
the effect of economic and market conditions on our business, prospects, financial condition or results of operations.
|
These statements are not guarantees of future performance and actual actions or results may differ materially. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict, including those noted in the documents incorporated herein by reference. Particular attention should also be paid to the cautionary language in Item 1A of Part II entitled “Risk Factors.” RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed by RealNetworks from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
Overview
RealNetworks creates innovative applications and services that make it easy to connect with and enjoy digital media. Following a reorganization that took effect in 2016, we manage our business and report revenue and operating income (loss) in three segments: (1) Consumer Media, (2) Mobile Services, and (3) Games. The historical financial information presented within this report has been recast to reflect this new segmentation. See
Note 18
Segment Information
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q.
Within our Consumer Media segment, revenue is derived from the sales of our PC-based RealPlayer
®
products, including RealPlayer Plus and related products and from the licensing of our intellectual property, primarily our codec technology, including our recently introduced RealMedia High Definition, or RMHD, technology. Distribution of these products and services are delivered directly to consumers and through partners, such as OEM and mobile device manufacturers.
Our Mobile Services business generates revenue primarily from the sale of our SaaS services, which include ringback tones, music on demand, intercarrier messaging and our LISTEN platform. This business also includes revenue related to Mobile RealTimes
®
, our recently introduced photo and video sharing application, that is primarily sold through mobile carriers and related partners.
Our Games business, through the GameHouse and Zylom brands, derives revenue from sales of games licenses, online games subscription services, sales of mobile games and advertising on games sites and social networks.
We allocate certain corporate expenses which are directly attributable to supporting our businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities, to our reportable segments. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. Also reported in our corporate segment are restructuring charges, lease exit and related charges, as well as stock compensation expense. Concurrent with the segment change described above, we also changed our expense allocation methodology to increase accountability, resulting in an increase in corporate costs allocated to the Consumer Media and Mobile Services businesses. The historical financial information presented below has been recast to reflect the new corporate expense allocation.
As of
March 31, 2016
, we had
$86.8 million
in unrestricted cash, cash equivalents and short-term investments, compared to
$99.1 million
as of
December 31, 2015
. The
2016
decrease of cash, cash equivalents, and short-term investments since December 31,
2015
was due primarily to cash used in operating activities during the quarter of
$11.2 million
.
For the
quarter ended
March 31, 2016
, our consolidated revenue declined by
$2.4 million
compared to the same period in
2015
. While revenue increased by
$2.0 million
in our Mobile Services business, revenue declined by
$2.3 million
and
$2.1 million
, respectively, in our Consumer Media and Games segments, as described more fully below.
Condensed consolidated results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
Total revenue
|
$
|
28,230
|
|
|
$
|
30,597
|
|
|
$
|
(2,367
|
)
|
|
(8
|
)%
|
Cost of revenue
|
15,172
|
|
|
16,547
|
|
|
(1,375
|
)
|
|
(8
|
)%
|
Gross profit
|
13,058
|
|
|
14,050
|
|
|
(992
|
)
|
|
(7
|
)%
|
Gross margin
|
46
|
%
|
|
46
|
%
|
|
|
|
|
Operating expenses
|
27,837
|
|
|
33,062
|
|
|
(5,225
|
)
|
|
(16
|
)%
|
Operating income (loss)
|
$
|
(14,779
|
)
|
|
$
|
(19,012
|
)
|
|
$
|
4,233
|
|
|
22
|
%
|
In the
first
quarter of
2016
, our total consolidated revenue declined by
$2.4 million
, compared with the year-earlier period. The reduction in revenue resulted from declines of
$2.3 million
in Consumer Media, due primarily to lower IP licensing revenue, and
$2.1 million
in Games, due primarily to the sale of the Slingo and social casino games business in the third quarter of 2015. Revenue from Mobile Services increased
$2.0 million
mainly due to higher music on demand sales in Korea. Although revenue decreased overall, gross margin remained consistent at
46%
during the
quarter ended March 31, 2016
as described in more detail in Segment Operating Results below. Operating expenses decreased by
$5.2 million
in the quarter ended
March 31, 2016
compared with the prior year primarily due to savings of $4.8 million realized from the sale of the Slingo and the social casino games business. Other factors contributing to the decrease in operating expenses were significant reductions in salaries and related personnel costs and professional service fees. These reductions were offset in part by the benefit recognized in the first quarter of 2015 relating to the warrants received from Rhapsody, higher restructuring costs, and higher stock compensation expense resulting from the first quarter 2016 authorization and grant of fully vested equity awards as payment for 2015 incentive bonuses.
Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
5,726
|
|
|
$
|
7,989
|
|
|
$
|
(2,263
|
)
|
|
(28
|
)%
|
Cost of revenue
|
2,417
|
|
|
3,464
|
|
|
(1,047
|
)
|
|
(30
|
)%
|
Gross profit
|
3,309
|
|
|
4,525
|
|
|
(1,216
|
)
|
|
(27
|
)%
|
Gross margin
|
58
|
%
|
|
57
|
%
|
|
|
|
|
Operating expenses
|
5,376
|
|
|
6,594
|
|
|
(1,218
|
)
|
|
(18
|
)%
|
Operating income (loss)
|
$
|
(2,067
|
)
|
|
$
|
(2,069
|
)
|
|
$
|
2
|
|
|
—
|
%
|
Total Consumer Media revenue for the
quarter ended March 31, 2016
declined
$2.3 million
when compared with the year-earlier period. IP licensing revenue declined by $1.7 million due primarily to the timing of contracts and contract renewals. Continuing declines in our legacy subscription products of $0.4 million coupled with a decrease of $0.3 million in our third party distribution revenue made up the remaining decline in Consumer Media revenue.
Cost of revenue decreased by
$1.0 million
during the
quarter ended March 31, 2016
, compared with the year-earlier period, in line with the overall decrease in revenue, resulting in a slight increase in gross margin during the period. The decrease in cost of revenue was primarily due to lower bandwidth costs.
Operating expenses decreased by
$1.2 million
in the
quarter ended March 31, 2016
, compared with the year-earlier period. The decrease was primarily due to reductions in salaries and related personnel costs of $1.4 million, marketing costs of $0.4 million, and professional services costs of $0.5 million. These declines were offset, in part, by a $0.7 million acceleration of depreciation expense related to the obsolescence of e-commerce assets as we moved this platform to a third party cloud service.
Mobile Services
Mobile Services segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
16,465
|
|
|
$
|
14,504
|
|
|
$
|
1,961
|
|
|
14
|
%
|
Cost of revenue
|
10,917
|
|
|
10,308
|
|
|
609
|
|
|
6
|
%
|
Gross profit
|
5,548
|
|
|
4,196
|
|
|
1,352
|
|
|
32
|
%
|
Gross margin
|
34
|
%
|
|
29
|
%
|
|
|
|
|
Operating expenses
|
9,794
|
|
|
11,961
|
|
|
(2,167
|
)
|
|
(18
|
)%
|
Operating income (loss)
|
$
|
(4,246
|
)
|
|
$
|
(7,765
|
)
|
|
$
|
3,519
|
|
|
45
|
%
|
Total Mobile Services revenue increased by
$2.0 million
in the
quarter ended March 31, 2016
, compared with the year-earlier period. This increase was driven by an increase of $3.1 million in our music on demand business in Korea and, to a lesser degree, from our RealTimes mobile services which we began to distribute through mobile carriers during the last quarter of 2015. These increases were offset by decreases in revenue from professional services provided to our mobile carriers, from our ringback tones and from our Helix product. In 2014, we ceased investing in our Helix product and we no longer sell it.
Cost of revenue increased by
$0.6 million
in the
quarter ended
March 31, 2016
compared with the year-earlier period, primarily from costs related to our music on demand service resulting from higher related revenue which was offset by savings from our other SaaS service offerings, such as professional services and ringback tones.
Gross margin increased from
29%
to
34%
in the
quarter ended
March 31, 2016
, due to system implementation revenue from our carrier partners relating to our RealTimes product.
Operating expenses decreased by
$2.2 million
for the
quarter ended
March 31, 2016
, compared with the year-earlier period, primarily due to reductions in salaries and related personnel costs of $1.5 million. Additionally, our marketing spend decreased by $0.6 million for the
three
months ended
March 31, 2016
.
Games
Games segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
6,039
|
|
|
$
|
8,104
|
|
|
$
|
(2,065
|
)
|
|
(25
|
)%
|
Cost of revenue
|
1,845
|
|
|
2,794
|
|
|
(949
|
)
|
|
(34
|
)%
|
Gross profit
|
4,194
|
|
|
5,310
|
|
|
(1,116
|
)
|
|
(21
|
)%
|
Gross margin
|
69
|
%
|
|
66
|
%
|
|
|
|
|
Operating expenses
|
5,295
|
|
|
8,683
|
|
|
(3,388
|
)
|
|
(39
|
)%
|
Operating income (loss)
|
$
|
(1,101
|
)
|
|
$
|
(3,373
|
)
|
|
$
|
2,272
|
|
|
67
|
%
|
Total Games revenue decreased by
$2.1 million
in the
quarter ended March 31, 2016
, compared with the year-earlier period primarily due to the sale of our Slingo and social casino games business in the third quarter of 2015. Revenue from this business was $1.8 million in the first quarter of 2015. In addition, we saw lower revenue in 2016 from subscription products of $0.5 million.
Cost of revenue decreased by
$0.9 million
in the
three
months ended
March 31, 2016
, compared with the year-earlier period. The decrease was primarily related to the sale of our Slingo and social casino games business.
Gross margin improved from
66%
to
69%
as a result of the sale of the Slingo and social casino games business, which had lower margins than our existing products.
Operating expenses declined by
$3.4 million
in the
quarter ended
March 31, 2016
, compared with the year-earlier period primarily due to $4.8 million of operating expenses in the first quarter of 2015 from our Slingo and social casino games business, offset by increases in salaries and related personnel costs and marketing expenses.
Corporate
Corporate segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
Cost of revenue
|
$
|
(7
|
)
|
|
$
|
(19
|
)
|
|
$
|
12
|
|
|
63
|
%
|
Operating expenses
|
7,372
|
|
|
5,824
|
|
|
1,548
|
|
|
27
|
%
|
Operating income (loss)
|
$
|
(7,365
|
)
|
|
$
|
(5,805
|
)
|
|
$
|
(1,560
|
)
|
|
(27
|
)%
|
Operating expenses increased by
$1.5 million
in the
quarter ended March 31, 2016
compared with the year-earlier period. The increase was primarily due to an increase in stock compensation expense as we authorized and granted fully vested equity awards for our 2015 incentive bonuses in the first quarter of 2016, as well as the benefit recognized relating to the warrants received from Rhapsody in the first quarter of 2015 and higher restructuring costs in the current quarter. These increases were offset in part by decreases in salary and benefit costs and professional service fees as well as increased allocations of costs from our Corporate segment to our Consumer Media and Mobile Services businesses, as discussed above.
Consolidated Operating Expenses
Our operating expenses consist primarily of salaries and related personnel costs including stock based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, restructuring charges and lease exit costs. Operating expenses were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
Research and development
|
$
|
9,319
|
|
|
$
|
12,379
|
|
|
$
|
(3,060
|
)
|
|
(25
|
)%
|
Sales and marketing
|
9,225
|
|
|
12,837
|
|
|
(3,612
|
)
|
|
(28
|
)%
|
General and administrative
|
8,077
|
|
|
7,283
|
|
|
794
|
|
|
11
|
%
|
Restructuring and other charges
|
385
|
|
|
485
|
|
|
(100
|
)
|
|
(21
|
)%
|
Lease exit and related charges
|
831
|
|
|
78
|
|
|
753
|
|
|
NM
|
Total consolidated operating expenses
|
$
|
27,837
|
|
|
$
|
33,062
|
|
|
$
|
(5,225
|
)
|
|
(16
|
)%
|
Research and development expenses decreased by
$3.1 million
in the
quarter ended
March 31, 2016
, compared with the year-earlier period. The decrease was primarily due to $2.2 million reduction from the sale of our Slingo and social casino games business and $1.4 million from a reduction in salaries and benefits costs and professional service fees. These decreases were partially offset by $0.7 million of depreciation expense related to the obsolescence of e-commerce assets as we moved this platform to a third-party cloud service.
Sales and marketing expenses decreased by
$3.6 million
in the
quarter ended March 31, 2016
compared with the year-earlier period. The decrease was primarily due to $2.0 million of reduction from the sale of our Slingo and social casino games business as well as $2.2 million of decreases in salaries and benefits costs, professional service fees and marketing expenses. These decreases were offset in part by an increase in stock compensation expenses for the fully vested equity awards authorized and granted for our 2015 incentive bonuses in the first quarter of 2016.
General and administrative expenses increased by
$0.8 million
in the
quarter ended March 31, 2016
, compared with the year-earlier period. The increase was primarily due to $1.2 million of a benefit recognized in the first quarter of 2015 relating to the warrants received from Rhapsody and an increase in stock compensation expenses for the fully vested equity awards authorized and granted for our 2015 incentive bonuses in the first quarter of 2016. These increases were offset in part by $0.5 million of a reduction from the sale of our Slingo and social casino games business in 2015 and reductions in salaries and benefits costs and professional service fees.
Restructuring and other charges and Lease exit and related charges consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. Restructuring expense is primarily related to severance costs due to workforce reductions. Lease exit costs for the
quarter ended
March 31, 2016
increased by
$0.8 million
over the prior year period primarily based on updated estimates of future lease costs from our vacated office space in our Seattle headquarters. For additional details on these charges see
Note 11
,
Restructuring Charges
and
Note 12
,
Lease Exit and Related Charges
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q.
Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
Interest income, net
|
$
|
117
|
|
|
$
|
200
|
|
|
$
|
(83
|
)
|
|
(42
|
)%
|
Gain (loss) on investments, net
|
3
|
|
|
299
|
|
|
(296
|
)
|
|
NM
|
Equity in net loss of Rhapsody
|
—
|
|
|
(6,180
|
)
|
|
6,180
|
|
|
100
|
%
|
Other income (expense), net
|
(287
|
)
|
|
443
|
|
|
(730
|
)
|
|
(165
|
)%
|
Total other income (expense), net
|
$
|
(167
|
)
|
|
$
|
(5,238
|
)
|
|
$
|
5,071
|
|
|
97
|
%
|
Gain (loss) on investments, net, for the
quarter ended March 31, 2016
declined from the prior year period as there were no sales of available for sale securities in the current period whereas we recognized a gain of
$0.3 million
from sales in the prior year period.
We account for our investment in Rhapsody under the equity method of accounting, as described in
Note 5
,
Rhapsody Joint Venture
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q. The net carrying value of our investment in Rhapsody is not necessarily indicative of the underlying fair value of our investment.
Other income (expense), net, reflected an expense of
$(0.3) million
compared with income of
$0.4 million
in the prior year period. This change was due primarily due to a change in foreign currency gain (loss) due to a change in exchange rates.
Income Taxes
During the
quarters ended
March 31, 2016
and
2015
, we recognized an income tax expense of
$0.2 million
and
$0.2 million
, respectively, related to U.S. and foreign income taxes. Besides changes in our jurisdictional income, the income tax expense recorded for the quarters ended
March 31, 2016
and
2015
has remained consistent.
As of
March 31, 2016
, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the
2015
10-K. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
The majority of our tax expense is due to income in our foreign jurisdictions and we have not benefitted from losses in the U.S. and certain foreign jurisdictions in the
first
quarter of
2016
. We generate income in a number of foreign jurisdictions, some of which have higher or lower tax rates relative to the U.S. federal statutory rate. Our tax expense could fluctuate significantly on a quarterly basis to the extent income is less than anticipated in countries with lower statutory tax rates and more than anticipated in countries with higher statutory tax rates. For the
quarter ended
March 31, 2016
, decreases in tax expense from income generated in foreign jurisdictions with lower tax rates in comparison to the U.S. federal statutory rate was offset by increases in tax expense from income generated in foreign jurisdictions having comparable, or higher tax rates in comparison to the U.S. federal statutory rate. The effect of differences in foreign tax rates on the Company's tax expense for the
first
quarter of
2016
is minimal.
As of
March 31, 2016
, we have not provided for U.S. federal and state income taxes on certain undistributed earnings of our foreign subsidiaries, since such earnings are considered indefinitely reinvested outside the U.S. or may be remitted tax-free to the U.S. If these amounts were distributed to the U.S., in the future in the form of dividends or otherwise, we could be subject to additional U.S. income and foreign withholding taxes. It is not practicable to determine the foreign withholding and U.S. income tax liability or benefit on such earnings due to the timing of such future distributions, the availability of foreign tax credits, and the complexity of the computation if such earnings were not deemed to be permanently reinvested. If future events, including material changes in estimates of cash, working capital, and long-term investment requirements necessitate that these earnings be distributed, an additional provision for U.S. income and foreign withholding taxes may be necessary.
We file numerous consolidated and separate income tax returns in the U.S., including federal, state and local returns, as well as in foreign jurisdictions. With few exceptions, we are no longer subject to United States federal income tax examinations for tax years prior to 2013 or state, local or foreign income tax examinations for years prior to 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.
Geographic Revenue
Revenue by geographic region was as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarters ended March 31,
|
|
2016
|
|
2015
|
|
$ Change
|
|
% Change
|
United States
|
$
|
10,383
|
|
|
$
|
12,349
|
|
|
$
|
(1,966
|
)
|
|
(16
|
)%
|
Europe
|
3,384
|
|
|
4,163
|
|
|
(779
|
)
|
|
(19
|
)%
|
Republic of Korea
|
9,233
|
|
|
6,324
|
|
|
2,909
|
|
|
46
|
%
|
Rest of world
|
5,230
|
|
|
7,761
|
|
|
(2,531
|
)
|
|
(33
|
)%
|
Total net revenue
|
$
|
28,230
|
|
|
$
|
30,597
|
|
|
$
|
(2,367
|
)
|
|
(8
|
)%
|
Revenue in the United States declined by
$2.0 million
in the quarter ended
March 31, 2016
compared with the year-earlier period. The decline was primarily due to the sale of our Slingo and social casino business in the third quarter of 2015. Revenue from this business was $1.8 million in the first quarter of 2015. In addition, we saw decreases of $0.5 million and $0.4 million from our license and subscriptions revenue in our Consumer Media business offset by an increase of $0.4 million from revenue in our Mobile Services business.
Revenue in Europe declined by
$0.8 million
in the quarter ended
March 31, 2016
compared with the year-earlier period. The decrease was due to a decline in our Games revenue of $0.5 million and a decline in our Mobile Services business of $0.3 million.
Revenue in Korea increased by
$2.9 million
in the quarter ended
March 31, 2016
compared with the year-earlier period. The increase, which was in our Mobile Services business, was due primarily to a $3.1 million increase in music on demand revenue.
Revenue in the rest of world decreased by
$2.5 million
in the quarter ended
March 31, 2016
compared with the year-earlier period. The decrease was primarily due to a decline in our Consumer Media business of $1.3 million as well as lower Mobile Services revenue of $1.1 million.
New Accounting Pronouncements
See
Note 2
,
Recent Accounting Pronouncements
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q.
Liquidity and Capital Resources
The following summarizes working capital, cash, cash equivalents, short-term investments, and restricted cash (in thousands):
|
|
|
|
|
|
|
|
|
|
March 31, 2016
|
|
December 31, 2015
|
Working capital
|
$
|
80,355
|
|
|
$
|
91,373
|
|
Cash, cash equivalents, and short-term investments
|
86,828
|
|
|
99,129
|
|
Restricted cash equivalents and investments
|
3,100
|
|
|
2,890
|
|
The
2016
decrease of cash, cash equivalents, and short-term investments from December 31,
2015
was due primarily to our ongoing negative cash flows used in operating activities, which totaled
$11.2 million
in the first
three
months of 2016.
The following summarizes cash flow activity (in thousands):
|
|
|
|
|
|
|
|
|
|
Three months ended March 31,
|
|
2016
|
|
2015
|
Cash provided by (used in) operating activities
|
$
|
(11,211
|
)
|
|
$
|
(20,094
|
)
|
Cash provided by (used in) investing activities
|
4,487
|
|
|
22,105
|
|
Cash provided by (used in) financing activities
|
(771
|
)
|
|
(1
|
)
|
Cash used in operating activities consisted of net income (loss) adjusted for certain non-cash items such as depreciation and amortization, and the effect of changes in certain operating assets and liabilities.
Cash used in operating activities was
$8.9 million
lower in the
three months ended March 31, 2016
as compared to the same period in
2015
. Cash used in operations was less due in part to a lower operating loss in 2016 than the same quarter in the prior year.
For the
three months ended March 31, 2016
, cash provided by investing activities of
$4.5 million
was due primarily to sales and maturities, net of purchases, of short-term investments, which totaled
$5.5 million
. This was partially offset by purchases of equipment, software and leasehold improvements of
$0.8 million
.
For the three months ended March 31, 2015, cash provided by investing activities of $22.1 million was primarily due to sales and maturities, net of purchases, of short-term investments of $27.1 million partially offset by purchases of equipment, software and leasehold improvements of $0.3 million as well as a $5.0 million advance made to Rhapsody in the first quarter of 2015.
Cash used in financing activities for the
three months ended March 31, 2016
was
$0.8 million
. This cash outflow was due to tax payments on shares withheld upon vesting of restricted stock during the quarter.
While we currently have no planned significant capital expenditures for the remainder of
2016
other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases.
We believe that our current unrestricted cash, cash equivalents, and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.
In the future, we may seek to raise additional funds through public or private equity financing, or through other sources such as credit facilities. Such sources of funding may or may not be available to us at commercially reasonable terms. The sale of additional equity securities could result in dilution to our shareholders. In addition, in the future, we may enter into cash or stock acquisition transactions or other strategic transactions that could reduce cash available to fund our operations or result in dilution to shareholders.
Our cash equivalents and short-term investments consist of investment grade securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one non-U.S. Government or non-U.S. Agency issue or issuer to a maximum of 5% of the total portfolio. These securities are subject to interest rate risk and will decrease in value if interest rates increase. Because we have historically had the ability to hold our fixed income investments until maturity, we do not expect our operating results or cash flows to be significantly affected by a sudden change in market interest rates in our securities portfolio.
We conduct our operations primarily in five functional currencies: the U.S. dollar, the Korean won, the Japanese yen, the British pound and the euro. We currently do not hedge the majority of our foreign currency exposures and are therefore subject to the risk of exchange rate fluctuations. We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. Our exposure to foreign exchange rate fluctuations also arises from intercompany payables and receivables to and from our foreign subsidiaries.
As of
March 31, 2016
, approximately
$16.7 million
of unrestricted cash, cash equivalents, and short-term investments was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. income and foreign withholding taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. Additionally, the Company currently has significant net operating losses and other tax attributes that could be used to offset potential U.S. income tax that could result if these amounts were distributed to the U.S. We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed. We do not expect restrictions or potential taxes on repatriation of amounts held outside of the U.S to have a material effect on our overall liquidity, financial condition or results of operations.
Off-Balance Sheet Arrangements
We have operating lease obligations for office facility leases with future cash commitments that are not required to be recorded on our consolidated balance sheet. Accordingly, these operating lease obligations constitute off-balance sheet arrangements. In addition, since we do not maintain accruals associated with certain guarantees, as discussed in
Note 17
,
Guarantees
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q, those guarantee obligations also constitute off-balance sheet arrangements.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Our critical accounting policies and estimates are as follows:
|
|
•
|
Estimating music publishing rights and music royalty accruals;
|
|
|
•
|
Estimating recoverability of deferred costs;
|
|
|
•
|
Estimating allowances for doubtful accounts and sales returns;
|
|
|
•
|
Estimating losses on excess office facilities;
|
|
|
•
|
Valuation of equity method investments;
|
|
|
•
|
Valuation of definite-lived assets;
|
|
|
•
|
Valuation of goodwill ;
|
|
|
•
|
Stock-based compensation; and
|
|
|
•
|
Accounting for income taxes.
|
Revenue Recognition.
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Physical products are considered delivered to the customer once they have been shipped and title and risk of loss have been transferred. For online sales, the products or services are considered delivered at the time the product or services are made available, digitally, to the end user.
We recognize revenue on a gross or net basis. In most arrangements, we contract directly with end user customers, and are the primary obligor. In such arrangements, we recognize revenue on a gross basis. In some cases, we utilize third-party distributors who are the primary obligor to sell products or services directly to end user customers. In such instances, we recognize revenue on a net basis.
In our direct to consumer operations, we derive revenue primarily through (1) subscriptions sold by our Games segment and subscriptions of SuperPass within our Consumer Media segment, (2) sales of content downloads, software and licenses offered by our Consumer Media, Mobile Services, and Games segments and (3) the sale of advertising and the distribution of third-party products on our websites and in our games.
Consumer subscription products are paid in advance, typically for monthly, quarterly or annual duration. Subscription revenue is recognized ratably over the related subscription time period. Revenue from sales of content downloads, software and licenses is recognized at the time the product is made available, digitally, to the end user. Revenue generated from advertising on our websites and from advertising and the distribution of third-party products included in our products is recognized as revenue at the time of delivery.
We also generate revenue through business-to-business channels by providing services within our Mobile Services segment enabling mobile carriers to deliver audio and video content to their customers and by selling software licenses and products and related support and other services. Revenue generated from services provided to mobile carriers that enable the delivery of audio and video content to their customers is recognized as the services are provided. Setup fees to build these services are recognized ratably upon launch of the service over the remaining expected term of the service.
Non-software revenue arrangements containing multiple elements are divided into separate units of accounting, after being evaluated for specific criteria. If the criteria for separation are met, revenue is allocated to the individual units using the relative price method. If the criteria are not met, the elements are treated as one unit of accounting and revenue recognition is delayed until all elements have been delivered. In the case of revenue arrangements containing software, elements are divided into separate units of accounting only when vendor-specific objective evidence has been established. In cases where vendor-specific objective evidence has not been established, undelivered elements are combined into one unit of accounting and are not recognized in revenue until all elements have been delivered.
Estimating Music Publishing Rights and Music Royalty Accruals.
We have made estimates of amounts that may be owed related to music royalties for our historical domestic and international music services. Material differences may impact the amount and timing of our expense for any period if management made different judgments or utilized different estimates. Under copyright law, we may be required to pay licensing fees for digital sound recordings and compositions we have delivered. Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or, for certain compulsory licenses where voluntary negotiations are unsuccessful, by arbitration. Our estimates are based on contracted or statutory rates, when established, or management’s best estimates based on facts and circumstances regarding the specific music services and agreements in similar geographies or with similar agencies. While we have based our estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, actual results may differ materially from these estimates under different assumptions or conditions.
Estimating Recoverability of Deferred Costs.
We defer costs on projects for service revenue and system sales. Deferred costs consist primarily of direct and incremental costs to customize and install systems, as defined in individual customer contracts, including costs to acquire hardware and software from third parties and payroll costs for our employees and other third parties. We recognize such costs as a component of cost of revenue, the timing of which is dependent upon the revenue recognition policy by contract. For revenue recognized under the completed contract method, costs are deferred until the products are delivered, or upon completion of services or, where applicable, customer acceptance. For revenue recognized under the percentage of completion method, costs are recognized as products are delivered or services are provided in accordance with the percentage of completion calculation. For revenue recognized ratably over the term of the contract, costs are recognized ratably over the term of the contract, commencing on the date of revenue recognition. At each balance sheet date, we review deferred costs to ensure they are ultimately recoverable. Any anticipated losses on uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract exceeds its estimated total revenue.
Assessing the recoverability of deferred project costs is based on significant assumptions and estimates, including future revenue and cost of sales. Significant or sustained decreases in revenue or increases in cost of sales in future periods could result in impairments of deferred project costs. We cannot accurately predict the amount and timing of any such impairments. Should the value of deferred project costs become impaired, we would record the appropriate charge, which could have a material adverse effect on our financial condition or results of operations.
Estimating Allowances for Doubtful Accounts and Sales Returns.
We make estimates of the uncollectible portion of our accounts receivable. We specifically analyze the age of accounts receivable and historical bad debts, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Similarly, we make estimates of potential future product returns related to current period revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns allowance. Significant judgments and estimates are made and used in connection with establishing allowances for doubtful accounts and sales returns. Material differences may result in the amount and timing of our revenue for any period if we were to make different judgments or utilize different estimates or actual future experience was different from the judgments and estimates.
Estimating losses on excess office facilities.
We made significant estimates in determining the appropriate amount of accrued loss on excess office facilities, including estimates of sublease income expected to be received. If we make different estimates, our loss on excess office facilities could be significantly different from that recorded, which could have a material impact on our operating results.
Valuation of Equity Method Investments.
We use the equity method of accounting for investments in circumstances where we have the ability to exert significant influence, but not control, over an investee or joint venture. We record our percentage interest in the investee's recorded income or loss and changes in the investee's capital under this method, which will increase or decrease the reported value of our investment. See
Note 5
,
Rhapsody Joint Venture
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q, for additional information. We initially record our investment based on a fair value analysis of the investment.
We evaluate impairment of an investment valued under the equity method if events and circumstances warrant. An impairment charge would be recorded if a decline in value of an equity investment below its carrying amount were determined to be other than temporary. In determining if a decline is other than temporary, we consider factors such as the length of time and extent to which the fair value of the investment has been less than the carrying amount of the investee or joint venture, the near-term and longer-term operating and financial prospects of the investee or joint venture and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery.
Valuation of Definite-Lived Assets.
Definite-lived assets consist primarily of property, plant and equipment, as well as amortizable intangible assets acquired in business combinations. Definite-lived assets are amortized on a straight line basis over their estimated useful lives. We review definite-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to future undiscounted cash flows the assets are expected to generate. If definite-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair market value.
The impairment analysis of definite-lived assets is based upon estimates and assumptions relating to our future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, and their resulting impact on the estimates and assumptions relating to the value of our definite-lived assets could result in the need to perform an impairment analysis in future periods which could result in a significant impairment. While we believe our estimates and assumptions are reasonable, due to their complexity and subjectivity, these estimates and assumptions could vary from period to period. Changes in these estimates and assumptions could materially affect the estimate of future undiscounted cash flows and related fair market values of these assets and result in significant impairments, which could have a material adverse effect on our financial condition or results of operations. For further discussion, please see the risk factor entitled, "Any impairment to our goodwill, and definite-lived assets could result in a significant charge to our earnings" under Item 1A Risk Factors.
Valuation of Goodwill.
We test goodwill for impairment on an annual basis, in our fourth quarter, or more frequently if circumstances indicate reporting unit carrying values may exceed their fair values. Circumstances that may indicate a reporting unit's carrying value exceeds its fair value include, but are not limited to: poor economic performance relative to historical or
projected future operating results; significant negative industry, economic or company specific trends; changes in the manner of our use of the assets or the plans for our business; and loss of key personnel.
When evaluating goodwill for impairment, based upon our annual test or due to changes in circumstances described above, we first perform a qualitative assessment to determine if the fair value of a reporting unit is more likely than not less than the reporting unit's carrying amount including goodwill. If this assessment indicates it is more likely than not, we then compare the carrying value of the reporting unit to the estimated fair value of the reporting unit. If the carrying value of the reporting unit exceeds the estimated fair value, we then calculate the implied estimated fair value of goodwill for the reporting unit and compare it to the carrying amount of goodwill for the reporting unit. If the carrying amount of goodwill exceeds the implied estimated fair value, an impairment charge to current operations is recorded to reduce the carrying value to implied estimated value.
Significant judgments and estimates are required in determining the reporting units and assessing the fair value of the reporting units. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital.
Stock-Based Compensation.
Stock-based compensation cost is estimated at the grant date based on the award’s fair value and is recognized as expense over the requisite service period, which is the vesting period. For stock options, the fair value is calculated using the Black-Scholes option-pricing model or other appropriate valuation models such as Monte Carlo simulation. The valuation models require various highly judgmental assumptions including volatility in our common stock price and expected option life. If any of the assumptions used in the valuation models change significantly, stock-based compensation expense for new awards may differ materially in the future from the amounts recorded in our consolidated statement of operations. For all awards, we are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting forfeitures.
Accounting for Income Taxes.
We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred income tax expense and deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled. We must make assumptions, judgments and estimates to determine the current and deferred provision for income taxes, deferred tax assets and liabilities and any valuation allowance to be recorded against deferred tax assets. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
Each reporting period we must periodically assess the likelihood that our deferred tax assets will be recovered from future sources of taxable income, and to the extent that recovery is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance result in either increases to income tax expense or reduction of income tax benefit in the statement of operations and comprehensive income. In certain instances, changes in the valuation allowance may be allocated directly to the related components of shareholders' equity on the consolidated balance sheet. Factors we consider in making such an assessment include, but are not limited to, past performance and our expectation of future taxable income, macroeconomic conditions and issues facing our industry, existing contracts, our ability to project future results and any appreciation of our investments and other assets.
As of
March 31, 2016
,
$16.7 million
of the
$86.8 million
of cash, cash equivalents, and short-term investments was held by our foreign subsidiaries.
As of
March 31, 2016
, we have not provided for U.S. federal and state income taxes on certain undistributed earnings of our foreign subsidiaries, since such earnings are considered indefinitely reinvested outside the U.S. or may be remitted tax-free to the U.S. If these amounts were distributed to the U.S., in the form of dividends or otherwise, RealNetworks could be subject to additional U.S. income and foreign withholding taxes. It is not practicable to determine the foreign withholding and U.S. federal income tax liability or benefit on such earnings due to the timing of such future distributions, the availability of foreign tax credits, and the complexity of the computation if such earnings were not deemed to be permanently reinvested. If future events, including material changes in estimates of cash, working capital, and long-term investment requirements necessitate that these earnings be distributed, an additional provision for U.S. income and foreign withholding taxes may be necessary.